OPINION: Fixing the Sri Lankan economy

By M. Rizwan Muzzammil

Introduction

The Sri Lankan economy is significantly weakened and at risk of catastrophic collapse. There is a need for the government to boost entrepreneurship and production. In order to do this the following two important hurdles to businesses must be addressed. The difficulties posed by these hurdles have caused an adverse environment resulting in businesses closing, downsizing operations or fleeing our shores. It has also caused a brain drain where younger, more productive individuals are leaving for other nations in droves.

Hurdle 1: Money printing

The CBSL (Central Bank) prints money to finance government spending.

Printing is a surreptitious form of wealth tax as it diminishes the buying power of those who hold savings in the form of money, as opposed to those who own wealth in assets such as real-estate or gold.

The population that is mainly disadvantaged are the middle class and poor, while those who are wealthier will retain their wealth by holding non-monetary assets.

Due to diminished buying power and high interest rates the capital investment from businesses is compromised resulting in slower economic growth.

Furthermore, the free money from printing results in the public sector becoming indisciplined and unnecessarily large.

The aforesaid ill effects of printing are not exhaustive. The reader may refer to Reference 1 for further information.

The CBSL is forced to print in order to finance excessive government and public sector spending. However due to the tremendous harm caused, it is necessary that both the CBSL and government work together to discipline themselves to save the economy.

Hurdle 2: The CBSL USD price-fix and government import bans

The CBSL has price-fixed the USD, and the government has banned non-essential imports.

The price-fix has given rise to a black market where the USD is traded at a realistic value. This unofficial market has caused exporters, foreign employees, tourists and individuals to avoid official channels for USD remittances. The price-fix has therefore caused a situation where USD inflows into the country is not as it should be.

The import bans have resulted in the downsizing and closure of businesses.

Free-market solution: Floating the USD eliminates the need for import bans

If the USD is floated, any export earned USD will need to be purchased at the market price. Since imports are urgent the USD price must increase.

This price increase will reduce import demand, in particular for non-essentials, thereby reserving scarce USD for what is essential. Import bans would thus become unnecessary as society based consumer demand will decide essential and non-essential items.

The price increase will encourage entrepreneurship in exports. As shortages alleviate, and provided LKR printing is stopped, the USD price will in due course stabilise.

Fuel shortages as an example

As an example of consumer demand determining essential use we can consider the fuel situation.

Fuel is fundamental to the economy as it is necessary for nearly all business activity. The lack of fuel has been debilitating to say the least, with transport, education, medical care, tourism and many other industries crippled, and vast numbers stuck in queues resulting in many productive hours lost.

The fuel shortage is ultimately due to the fact that it is paid for using USD purchased at an artificially low price set by the CBSL. This results in a lower price paid by consumers and excessive usage in relation to the state of the economy.

A floated USD may result in an extremely high market driven fuel price. However this will automatically restrict excess use thereby reserving fuel for essential needs such as ambulances, hospital generators, transport of food, and so on. This free-market imposed discipline will make redundant the quota system.

It should be noted that high fuel prices would only persist in the short term. In time, as the economy regrows and provided LKR printing is stopped, the fuel price will become affordable.

As a general principle, it is better to have products at high prices than no products at all.

The evidence of history

Chile and West Germany have undergone a similar situation to what Sri Lanka is facing now. Both nations attempted exchange controls, import bans and money printing when faced with deteriorating economies.

Under enlightened guidance from the Chicago Boys (Chile) and Ludwig Erhad (West Germany) both nations subsequently abandoned these policies and allowed the free-market to take over.

Within weeks the free-market had alleviated shortages. Thereafter both these nations enjoyed strong growth and have reached first world status.

The examples of East Germany and Venezuela, on the other hand, are pertinent as they are culturally and traditionally similar to West Germany and Chile respectively. Both these nations persisted with the same adverse policies, resulting in the continued deterioration of their economies.

Though East Germany escaped complete collapse after reuniting with the West, Venezuela is now in the depths of hardship with four of five Venezuelan households living in poverty and more than 52% of the population living in extreme poverty.

Reference 2 provides more information on this historical evidence.

The free-market can solve problems most quickly only if it is allowed to

Policies conducive to the free-market are essential to solving the serious economic problems. The free-market is a system that grows organically and spontaneously in the absence of government control. The interpretation here is not that the government does too little, but rather it does too much!

This means the government must “let go”. It must relax its suffocating hands, liberalise and abolish laws that interfere with business. It must take determined steps to decouple itself from business activities.

The bitter medicine is necessary, urgent; requires bravery and courage!

The aforesaid recommendations are likely to drive up prices and cause significant hardship to the people in the short run. For this reason implementation by the political leadership requires substantial bravery and courage.

But this bitter medicine must be taken while there is still time and a two to three fold cost of living increase can still be tolerated. In this situation the rich and middle class at least would still be in a position to help the underprivileged.

If the policy amendments are not done, then the economy will continue to weaken, and as each day passes Sri Lanka will come closer to the brink. In Venezuela these similar policies caused ridiculously high inflation rates of 53,798,500% between 2016 and 2019. Sri Lanka could be the next example of this tragedy.

References

1. The Ethics of Money Production by Jörg Guido Hülsmann (free version available on mises.org)

2. The Power of Capitalism by Rainer Zitelmann

(The writer, a Sri Lankan citizen, has a Bachelor’s degree in Civil Engineering from the National University Singapore. He has a keen interest in economics. He can be reached at write2rizwan.m@gmail.com.)